Despite market conditions, retail properties have proven to be among the more resilient asset classes. Specifically, quick-service restaurants (QSRs) have have maintained strong performance but there is still pressure from high inflation. Quick service restaurants are passing the higher costs of ingredients, labor, and rent to the consumer as prices have outpaced inflation since 2009 (1). In fact, some items have more than doubled in price. For example, a McDonald’s Quarter Pounder cheeseburger meal once cost $5.39 in 2014 and now is priced at $11.99 (2). While inflation is among the major factors impacting the restaurant industry, labor shortage and labor quality has also diminished. TD Bank conducted a survey with 300 franchisees where 32% cited labor shortage and 69% cited decreases in labor quality as challenges facing their operations (3). Quick service restaurants have shown resilience in the current environment, but persistent inflationary pressure, labor shortages, and labor quality highlight the ongoing hurdles facing the industry.
Despite the challenges facing the QSR industry, consumer demand remains strong. For instance, demand for spaces is strong as vacancies for QSRs in single-tenant locations reached 1.3% at the end of 2023 (4). As a result of high occupancy, chains have planned expansion through new builds. Chipotle plans on opening about 300 new stores in 2024 and hiring around 19,000 new employees (5). McDonald’s has loftier goals, aiming to add 500 locations in the U.S. in 2024 and 10,000 locations globally by 2027 (6). Due to the limited supply and increased demand, developers have the ability to raise rents due and achieve favorable economic terms in leases such as lower tenant improvement allowance and longer terms. This in-turn allows developers to get improved lender terms.
While customer demand remains above average, QSRs have found ways to decrease costs and improve their bottom line by implementing innovative technologies and efficient operating models. Since the pandemic, the consumer’s preference for convenience has increased, encouraging chains to adopt drive-thrus, technology-integrated spaces, and lower seat-count. Last year, Sweetgreen opened its first location with the Infinite Kitchen – an automated machine that dispenses ingredients to make salad bowls. This innovation could cut their makeline labor force costs by 70%, which makes up about half of Sweetgreen’s labor costs (7). Other chains have taken different approaches to improving their bottom line. Hardee’s shrunk their interior seating by 25% in their latest prototype (8). Just as ambitious, Starbucks plans on opening 400 delivery or pickup only locations in the U.S. within the next three years (9).
Shrinking footprints has been a trending tactic for QSRs to improve profitability. For example, 7 Brew, a drive-thru and pickup only coffee concept, focuses on smaller footprint spaces to capture the consumer demand for convenience and efficiency. The brand uses modular construction to build 500 square foot buildings and they target 15,000 square foot sites (10). This results in lower rental costs and operating expenses in comparison to traditional QSR sites, which have an abundance of seating and full kitchens, ranging from 1,600 to 2,800 square feet in building area. (11). The concept of extremely small quick service restaurants has piqued the interest of investors as well, evidenced by Blackstone’s minority stake investment in 7 Brew in February of this year. This model is attractive to investors given the low overhead costs and high demand from consumers – we could see further institutional investment in similar concepts in the future.
Out of all the innovations happening in the QSR industry, the small footprint model will have the greatest effect on real estate developers and investors. From the operator’s outlook, these concepts are great for increasing earnings. However, potential long-term issues could arise with such a unique, purpose-built concept. With a 500 square foot building, it is difficult to find alternative uses other than a drive-thru coffee concept. Realistically, these spaces can only be filled by another drive-thru-only concept that does not require a kitchen or seating, which severely limits an owner’s options for releasing. Developers and investors alike are exposed to the risk that demand could slow down for these concepts, in which case they could be stuck with a dysfunctional building. On the other hand, smaller buildings result in the benefit of lower construction costs compounded by increased annual rents. The benefits could potentially outweigh the risks of these projects, however, developers must consider this outcome. The smaller footprint concept begs the traditional, but potentially dying, fast-food question: for here or to-go?
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